VC Perspectives from a Former Entrepreneur – Jeff Bussgang

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Monthly Archives: February 2005

When I first jumped into the VC business and hung up my entpreneurial spikes, I was teased by friends that I had gone over to "the Dark Side". As the saying goes, there’s truth in jest. I’ve been surprised at the negative reputation the VC business has. In analyzing why that might be, I have been struck by a few common themes. With half apologies to David Letterman, here are the top 5 reasons my entrepreneur friends harp on as to why they dislike VCs:

5) You know the farm story about the commitment levels of the chicken and the pig towards breakfast? Guess who’s the VC and who’s the entrepreneur?

4) Work ethic. CEO: "I need to have a BOD call next week to drive to a decision on this." VC: "I’m in the Himalayas for the next 3 weeks and then at a week-long offsite with my partners in Aspen, so let’s just cover this at the next quarterly BOD meeting."

3) Varying defintions of value-add. Entrepreneur: "I need strategic insight, business development contacts, recruiting assistance, M&A and financing introductions." VC: "We need to work on stronger revenue growth, gross margins, and our competitive position. See you at the next Board meeting."

2) Take credit for successes, abandon failures. VC: "I was like a co-founder there." Entrepreneur: "Funny, I didn’t see you at my 7am weekly staff meetings."

1) Board room M.O.: show up late, pound on the Blackberry, look up and ask a question that was answered 2 hours ago.

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Many entrepreneurs focus on the amount of capital they raise (which always shows up in the press release) and on pre-money valuations (which never shows up in the press release!), but the truth is that the most important thing that matters (assuming "clean terms", which will be the subject of another post) is what I call "Cap Table Math" — the composition of the percentage ownership, or capitalization table, at the end of the financing.

Let’s take a typical series A example and keep the math simple. Jane and her technical co-founder have a killer idea, 20 rockin’ Power Point slides and a solid prototype. She lures in two VCs to invest $2.5M each for a total of $5.0M invested to buy 50% of the company – in other words, a pre-money valuation of $5.0M and a post-money valuation of $10.0M. These VCs inform Jane that although they love her and the idea, there needs to be 25% of the company set aside for all the future hires. So, VCs get 50%, future managers get 25% and the entrepreneurs get the remaining 25%. That’s pretty typical. After a series B round of, say $8M on $12M, where another 40% of the company is sold to investors, more options are created and everyone gets diluted, the founders’ ownership may drop down to 10-15%.

But let’s say Jane decides she can build the company with $1M of angel money from friends and family, giving up only 20% of the company (i.e., $1M raise on $4M pre). And, she controls the option pool more tightly in the early days rather than hiring high-powered executives, say doling out only 10%. Thus, she and her founding team have 70% ownership after the angel round and a few key hires. When it comes time to do the $4M Series A round (to match the $5M of total capital in the earlier scenario), she should be able to command a higher pre-money valuation, perhaps $8M, thus giving up only 33% to the VCs and, even with management ownership of 25% post-money, she and the founding team can keep 42% — a substantially larger share than in the previous scenario (25%).

So should entrepreneurs, mindful of ownership, always focus on taking money from angels rather than VCs? It’s not so simple. If a VC is offering you $5M, it’s hard to turn that down for $1M in angel money when there’s no guarantee more money will show up at a higher price down the road after the angel money runs out. More money means more runway, which often leads to a better outcome. And, in theory, a good, hands-on VC will add more value than an angel.

As with every tough decision, it depends, but at the end of the day, VCs and entrepreneurs should pay less attention to "pre-money" and instead focus on the make up of the cap tables and, ultimately, the percentage ownership that results when the dust settles.

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Welcome to "Seeing Both Sides". I was inspired to start this blog for many reasons, but the most important one is to help entrepreneurs. During my ten years as an executive at start-ups (such as Upromise and Open Market), I often viewed the venture capital business as a black art. Now that I've had a few years to practice that black art, I hope to help demystify it for other entrepreneurs.

Like most experiments, I will start this one off small and see where it leads. If this blog can help both educate and entertain, it will have served its purpose.

I will avoid promoting Flybridge Capital and our portfolio companies, but will instead leave that to our website and other vehicles. Feel free to keep me honest on all fronts with your feedback. Enjoy!